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Hats off to Berkshire Hathaway for the dividend it just declared—and to the other cash-rich companies that are distributing profits using the same strategy. The list of smart dividend payers includes AutoZone, Biogen Idec, Fiserv and Intuit.

Warren Buffett speaking to a group of students from the Kansas University School of Business (Photo credit: Wikipedia)

Perhaps you didn’t know that the wily Warren Buffett has declared a dividend. You might also be perplexed at other companies cited, since officially they pay out nothing.

The reason you didn’t know about the Berkshire dividend is that it was announced using different terminology. Buffett said that he was going to use some of his company’s ample cash flow to buy in shares.

The purpose of this essay is threefold: to show how share buybacks are just dividends in disguise; to explain the tax dodge that comes with the buyback, and to establish that buyback naysayers don’t know what they are talking about.

The conventional way for a corporation to disburse excess cash is to mail checks to its shareholders. That is the usual meaning of “dividend.” But a share repurchase, in which the company buys its own shares in the open market, is economically equivalent.

Consider the hypothetical corporation C. It issues 1 million shares at $100 each, invests the capital, and at the end of the year has $8 million of profit. At that point the shares (absent any change in the public’s view of C’s prospects) are worth $108 each.

If C declares an $8 dividend, the share price falls from $108 to $100 on the day the dividend goes ex. If you had bought 1,000 shares, you now have in your hands 1,000 shares worth the same $100,000 you started with, plus a check for $8,000.

Suppose instead that C, rather than pay the dividend, buys in 74,074 of its shares at $108 each. It will disburse the same $8 million. If you choose to sell 74 of your shares, then you are left with 926 shares worth $100,000 (I’m rounding) plus a check for $8,000.

Note that neither corporate disbursement altered the wealth of the shareholders. They had $108 million before the dividend or buyback, and $108 million after.

Your own $108,000 pile is left unaltered. You have the same wealth before and after the action by the corporate treasurer. Except for one thing: Now, unless your shares are protected by a shelter such as an IRA, you have a tax bill.

The tax bills differ. With the dividend you have $8,000 of dividend income. With the sale of 74 shares you have a capital gain of $592.